Are We Building An Apartment Bubble?

A Bloomberg report from Seattle says, yes, there and in few other places, we may be:

Seattle went from “dead last” in rent increases three years ago, following the collapse of mortgage lender Washington Mutual Inc. (WAMUQ), to 13th out of 88 markets last year, according to Axiometrics Inc., a multifamily real estate research company. The construction boom spurred by rising rents is now stoking concern that revenue growth may stall as an increasing number of units compete for tenants.

...“Around the country, we are seeing this trend of development concentrated in the urban core,” said Ron Johnsey, president of Dallas-based Axiometrics. “If the operators, lenders and investors are not careful, the urban core submarkets will become overbuilt in a couple of years.”

The story arrives a couple weeks after another, from Orlando, that lead with this terrifically flippant line from a developer: "We always overbuild something. This time will probably be multifamily."

Are we building too many of these?

Neither story sticks a firm landing. The concern is that the rapid escalation in rental demand will soon taper off, leaving a empty glut of apartments in central cities. Amazon and Boeing may not bring as many jobs to Seattle as advertised, people may not flock to D.C. in such high numbers, and so on. But the investment risks don't seem absurdly out of line with real estate market as a whole. And the idea that major cities are witnessing a bubble of apartment construction flies in the face of the argument that major cities need a bubble of apartment construction. Recent research, like this monetary policy paper, points to a dearth of multifamily housing, not a glut:

The housing stock is not prepared for this flow of renters, suggesting potent ally severe rental shortage. Currently there are 43.7 million rental units and 9.4% or 4.1 million are vacant. Multifamily construction is running at about 200,000 apartment completions per year, and cannot possibly meet this shift in demand at current prices. The vacancy rate has never fallen below about 7% in the last 20 years.

Now, fresh numbers from Reis Inc. show that apartment vacancies have dipped below 5%, the lowest rate since 2001. It's this market tightening that has landlords and investors concerned that, in places like Seattle, the trend could suddenly reverse. From the numbers I've seen, I don't see that point approaching, at least in the coastal cities. I'm with Paul Menzies, of Laconia Development LLC, who told Bloomberg: “I don’t think we’re anywhere near the top of the cycle.” Elaine Misonzhnik, with National Real Estate Investor, reports that overbuilding risks won't arrive until 2013.

What's more uncertain, and more risk-inducing, and more likely to swiftly change things next year, is the state of rental financing. Buried down in the FHFA plan to restructure the GSEs, from February, was a proposal to essentially unleash multifamily financing solely to the private sector. That means that normal operations for funding, underwriting, and sustaining rental projects could be totally reshuffled. Since the market collapse, the GSEs, as in the single-family sector, have picked up the lion's share of financing for rental developments. From 2008 to 2010, the number of multifamily loans held or guaranteed by the Feds (the GSEs and FHA) went up by $71 billion, according to a Harvard report. At the same time, private financing dropped by $41 billion.

A private-only sector wouldn't necessarily doom the market. Yet it could throw out the more stringent GSE standards, which have performed much more reliably than commercial backed loans. A GSE exit could also pull the rug from bountiful financing. Here's the kicker, from the National Multi Housing Council: "The private market simply cannot meet 100% of the multifamily sector’s demand for capital."

At this point, when more people are lining up to rent in the downtowns of Seattle, and even Orlando, overbuilding shouldn't be a major concern. But perhaps an under-financed future should be.